Storytelling has a universal appeal, and storytelling narratives are a powerful force influencing investment trends. However, popular investment narratives often lead investors to make poor decisions. Some popular narratives are inherently off-target, while other narratives persist beyond a logical sell-by date. Today’s popular narratives offer a conventional wisdom about such topics as technology companies, index investing, and demographics.
Investors should cast a critical eye at the conventional wisdom, assessing the merit and durability of the concept, while identifying scenarios that could disrupt the investment outlook:
FANG and other platform stocks can’t be stopped. The FANG stocks — Facebook (Nasdaq: FB), Amazon.com ( AMZN), Netflix ( NFLX) and Google ( GOOG, GOOGL) — as well as Apple ( AAPL) and Microsoft Corp. ( MSFT), are considered to be among the leading platform companies that benefit from network effects.
Platform companies provide an ecosystem in which companies plug into the platform to add incremental value or gain access to a network of potential customers. Platforms such as Apple’s are thought to be in “winner take all” or “winner take most” industries.
[See: The Fastest Ways to Lose All Your Money in the Stock Market.]
Amazon and Netflix have lofty valuations, with both trading above 100 times estimated earnings for next year. It is reasonable to question whether Amazon will be able to sustain its growth, improve its profitability, and “grow” into its stock market valuation multiple.
Netflix may also face challenges growing into its valuation, given that the Netflix platform may be vulnerable to potential challenges from content providers such as Walt Disney Co. ( DIS). Antitrust considerations may also prove to be an issue for some platform companies, as Google is painfully discovering in their dealings with the European Commission.
Although Amazon, Netflix and Google are great companies, it isn’t a given that they will each be great stocks to own in the future.
Index funds will replace active funds. The rise of index funds is a significant investment trend, and annual outflows of hundreds of billions of dollars from actively managed funds show no sign of abating. Index funds offer considerable benefits, but narratives that sound the death knell for active management may be off target. The higher the proportion of passive investment in an asset class, the more likely that market prices will diverge from fair value. Increases in mispricing relative to fair value will inevitably draw money into actively-managed strategies.
Actively-managed strategies may also thrive in asset classes in which active managers have tended to outperform passive managers, or in asset classes in which indexes are flawed or are highly fluid in nature.
Robots will replace humans. Quantitatively-driven strategies such as smart beta are increasingly popular, benefiting from advances in artificial intelligence, big data and machine learning. Quantitative algorithms may be superior to humans at recognizing past patterns and identifying subtle trends in large sets of data.
Although quantitative models are superior to humans in looking through the rear-view mirror, humans still may be better equipped to identify future trends. The combination of humans and machines may be more likely to “win” than either independently of the other.
Demographic challenges sentence the developed world to decades of slow growth. Japan is considered an object lesson for the rest of the world, demonstrating the challenges of maintaining economic growth as a society ages. Demographic trends are seemingly inexorable, with the mathematics of births, deaths and old age leading to a challenging environment for many developed-markets countries.
[See: 9 Ways to Buy Stocks That Everyone Needs.]
However, lessons from the past may illustrate the potential shortcomings of conventional wisdom. People born in 1900 were likely to die before age 50, and most people in 1900 probably didn’t expect major changes in life expectancy during their lifetimes. Advances in treatment of infectious diseases, declining infant deaths and cleaner water contributed to dramatic improvement of life expectancy in subsequent decades.
The demographic trends of today may be less inexorable than thought, as advances in CRISPR/Cas9 gene editing technology and immunotherapy for treating cancer could extend lives and improve late-in-life quality of life. Although CRISPR/Cas9 and immuno-oncology are in early stages of development, the potential economic and societal implications of longer, healthier lifespans would be game-changing.
The reach for yield won’t end badly this time. Investors seem complacent about the outlook for high yield and emerging markets debt, despite mounting indications that the reach for yield may be riskier than indicated by today’s narrative about credit. Two of this year’s larger debt offerings provide evidence investors may be underestimating potential risks.
In May, Netflix issued more than 1 billion euros of bonds with a 10-year maturity and coupon rate of 3.625 percent. Netflix is projected to have $2 billion of negative cash flow this year and faces considerable potential competition. It’s logical to wonder whether Netflix bondholders are being appropriately compensated for their risk, yet the deal was three times over-subscribed.
In June, Argentina issued a 100-year bond, raising $2.75 billion in another oversubscribed deal. Argentina has defaulted on its debts five times in the last 100 years, and has spent 75 years of its two-century history in default. Although Argentina seems to be heading on a positive economic path, it seems less-than-prudent to assume today’s narrative about Argentina’s political stability and willingness to pay will persist for the next century. A quote from famed investor Howard Marks may be instructive: “You want to take risk when others are fleeing from it, not when they’re competing with you to do so.”
There are viable arguments and counter-arguments for each of these popular narratives. The FANGs (and Apple and Microsoft) are amazing companies, index funds are likely to continue to grow in popularity and medical science may not move fast enough to meaningfully change demographic trends. However, the wise investor should look at both sides of the argument, rather than accepting narratives at face value. Closing with the wisdom of Howard Marks, “Move forward, but with caution.”
[See: 10 Smart-Beta ETFs That Will Help You Get Your Alpha.]
Disclosures: Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal. This communication may include opinions and forward-looking statements. All statements other than statements of historical fact are opinions and/or forward-looking statements (including words such as believe, estimate, anticipate, may, will, should and expect). Although TFC Financial Management believes that the beliefs and expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such beliefs and expectations will prove to be correct. Unless stated otherwise, any mention of specific securities or investments is for hypothetical and illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable. Nothing in this communication is intended to be or should be construed as individualized investment advice. All content is of a general nature and solely for educational, informational and illustrative purposes.
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Beware of These 5 Popular Investment Narratives originally appeared on usnews.com
